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Ideas and Strategies on Investing.

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The Exit Strategy

11/18/2014

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The exit strategy is always a mandatory precondition for any trade I enter.

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All other strategies will have disaster embedded at their core. All other strategies are simply an emotional reaction to events external to the markets. All other strategies will accentuate a reward while ignoring the damage that's incurred by accepting such an extensive implied risk. These are the strategies that I personally refuse to implement into my trading strategy. 

My trading and investing success is simple and it's based on controlling risk, preserving capital, and increasing gains where possible. It's a strategy based on level of maturity that can only be acquired through pain and persistence. Once I survived the freshman errors of the beginner trader, I began to survive and prosper as an investor.


Novice traders are initially emotional creatures as they begin their trading career, regardless of how long or short their trading career lasts. It’s not their fault. It happens to everyone. It’s caused by the excitement of “easy money”. Most beginner traders worked hard to put together a sum of money to afford them the ability to establish their first trade and what they discover that by simply clicking a mouse a few times they can open a brokerage account, buy a stock and, if they’re correct in their decisions, sell their stock realizing both a profit as well as the excitement of receiving the easiest money they’ve ever made in their entire lives.

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That type of situation is extremely addictive to the novice trader. It provides an emotional high and an enormous boost to their self confidence. It enhances their self image, and it's an enormous and transformative ego boost. Finally it's a confirmation that they are smarter than the average trader. They conclude that trading is easy, obvious, and they wonder why they hadn’t done this long before now. But like most things that are addictive, the emotional high only lasts so long before an ugly reality begins to set in.

As a stock moves up in value, greed begins to creep into the psyche of the novice trader. He begins to calculate how many years will it take before he’s a millionaire. He begins to calculate how he can double down on his investments to speed up this accumulation of wealth. Greed becomes the single most important factor in his trading decisions while risk is ignored. It isn't long before disaster arrives.

Sadly many novice traders will eventually lose all their capital and exit the market forever. They'll end up blaming the markets for what was actually their own inability to control risk. They'll let their emotions control their trading decisions because they don't have a plan to control the risk associated with even their smallest trade. As much as their greed encouraged increased trading when the trades were successful, fear now discourages their trading when their trading becomes unsuccessful.

Trades that are going poorly bring to the surface of the trader’s psyche his inherent fear of bankruptcy and a life of poverty. As much as greed makes the novice trader dream of becoming a millionaire, fear makes the novice trader anxious over losing everything and falling into that abyss of poverty. It’s the natural psychological conclusion for a trader whose trades are based on emotions and his emotions are out of control. 


An experienced and much wiser trader would simply accept the loss, sell the position, and move on to the next trade. A novice trader who had been bolstered by earlier successes would interpret this situation as the market being wrong, that he is still right, and that the market will eventually understand and correct itself. 

His fear traps him into holding onto a losing trade until his account is completely decimated. In the end these stocks often lay dormant in accounts for years because investor’s unwilling to declare defeat and sell. It’s a sad situation but it occurs everyday in the markets. The only value these trades may ever have will be as a tax offset for future successful trades.

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There is only one way that I know of to stop this disastrous style of trading based on emotions. That’s having a trading plan in place before the initial trade is executed. A good trading plan will have specific conditions for entering a trade as well as the resultant specific conditions for exiting a trade. A good trading plan will have a back up plan for when the trade acts differently than originally expected. A good trading plan will be simple, and it should be written down as a set of simple rules and conditions. And finally it’s one that can be executed successfully.

It is this exit strategy of how and when to exit a trade that makes a trader successful. It’s this exit strategy that keeps a trader trading for decades instead of weeks. It’s this exit strategy that eventually turns the mediocre trader into the successful investor.


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    I am an Individual Investor with specific interest in long term growth and then enhancing my returns with income from dividends and derivatives. I don't recommend stocks to anyone (it's a good way to lose friends) and no one reading this should misinterpret my blog as a recommendation for any type of investment. I am writing this solely for myself and my kids.


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